During the virtual Jackson Hole meeting, Fed chairman Jerome Powell announced the results of a year-long strategic review of the Fed’s policy framework. The updated Statement on Longer-Run Goals and Monetary Policy Strategy by the FOMC is now underpinned by a more dovish revision to employment and inflation objectives and therefore, also policy action.
The FOMC’s adoption of a flexible form of average inflation target of two per cent, was the primary outcome from the strategy review. Fed chairman Powell announced that going forward, “following periods when inflation has been running persistently below two per cent, appropriate monetary policy will likely aim to achieve inflation moderately above two per cent for some time”. Essentially, the average inflation objective introduces a more dovish long-term stance on interest rates as monetary policy will leave interest rates lower for longer, in order for inflation to run above the two per cent target.
The flexible approach to achieve an average level of inflation over time, implies that the Fed monetary policy decisions will still continue to reflect a broad array of considerations, rather than a mathematical formula. In fact, the Fed Chairman Powell reiterated that the FOMC would not hesitate to act in the event of excessive inflationary pressures.
Given that the Fed holds a dual mandate, Fed chairman Powell also communicated the review of the goal for maximum employment, now defined as a “broad based and inclusive goal”. The review has shifted its focus on the importance of maintaining a strong labour market. Going forward, policy decisions will be driven by the "assessments of the shortfalls of employment from its maximum level" rather than by "deviations from its maximum level".
The Fed has chosen a more asymmetric approach to the goal of maximum employment. Monetary Policy will be used to reduce unemployment rates when employment is below its maximum level, but the Fed will now allow employment levels to run at or above the estimated maximum. This is underpinned by the change in view that “a robust job market can be sustained without causing an outbreak of inflation". This objective also introduces a more dovish long-term stance on interest rates as the Fed will no longer tighten monetary policy solely based on the fact that employment has reached the estimated maximum level.
What ultimately motivated the review, were concerns about inflation levels persistently below the Fed’s two per cent long run objective. While low and stable inflation is key to a well-functioning economy, a persistent level of low inflation anchors long term inflation expectations below the long-term target. Given that interest rates are closely tied to inflation expectations, interest rates would also remain low and close to the effective lower bound, which limits the capacity of monetary policy to boost the economy through interest rate cuts.
The strategic review aims to avoid this limitation on monetary policy action. Essentially, by tolerating a higher level of inflation, the updated Fed’s policy framework increases the Fed’s ability to generate a higher rate of inflation, once the confidence in the economic recovery picks up.
Disclaimer: This article was issued by Rachel Meilak, CFA equity analyst at Calamatta Cuschieri. For more information visit, www.cc.com.mt. The information, view and opinions provided in this article are being provided solely for educational and informational purposes and should not be construed as investment advice, advice concerning particular investments or investment decisions, or tax or legal advice.